Family Dollar: Good Earnings Yet Stock Smashed

By Greg Sushinsky | December 29, 2010 AAA

Family Dollar Stores (NYSE:FDO) posted substantial earnings and revenue increases for its first quarter. Comparable same store sales were up as well. The strong figures made for an earnings miss, however, as the record performance failed to beat the forecast.

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A Record Quarter
Family Dollar's same store sales increase of 6.9% represented "the best first quarter results we've delivered in more than 12 years," according to Chairman and Chief Executive Howard R. Levine. Increased customer traffic drove this, although average transactions were flat. Lower priced candy and food items were the leading categories.

Revenue was $1.997 billion, compared to $1.823 billion in the first quarter a year ago. Net income was $74.3 million or 58 cents per diluted share, compared to $67.6 million or 49 cents per diluted share in last year's quarter. The revenue increase was 9.5%, net income increased 9.9%, while EPS was up 18%. These are outstanding increases, yet the market slammed the stock, taking it down nearly 9% on the news.

What the Market Is Doing
The market had earlier sent Family Dollar and dollar store stocks such as Dollar General (NYSE:DG), Dollar Tree (Nasdaq:DLTR) and 99 Cents Only Stores (NYSE:NDN), soaring this year as their sales surged. The dollar stores have thrived on customers who are trading down in order to save money, but this is a trend that the Street thinks is about to unwind. So, the market has accumulated and is now distributing dollar stores' shares in a classic pattern of cyclicality. This is what the market does.

Furthermore, when a stock is jumped on in today's market, momentum and program trading will exacerbate this. The Street looks for any sign of business or stock weakness. BJ's Wholesale (NYSE:BJ) had a similar December sales performance as Family Dollar, and suffered a similar fate. Family Dollar's December sales were up 4%, less than the quarter's total same-store increase of 6.9%. The Street perceive this as slowing growth. This factor, along with an economy that improves on the first signs of a reduction in unemployment, which historically has sent customers away from the low-cost dollar stores to full-price retailers, has the Street spooked. (For related reading, see The Power Of Program Trades.)

Family Dollar's Outlook
The company expects a $3.05 to $3.23 earnings per share compared with $2.62 for fiscal 2010. Family Dollar is looking for an increase in net sales of 8-10%, with same store sales up 5-7%. Capital expenditures of between $300 million and $350 million are expected. While 80 to 100 stores are expected to be closed, 300 new stores will be built. This response, along with Dollar General's plans to build 625 new stores and hire 6,000 new workers, shows the dollar stores are undeterred by their cyclical history. They intend to fight this history. The dollar stores have included more national brands in their merchandise in a move to retain their new higher income customers and keep them coming back long after the recession has passed. Also, in a development the Street dismissed, higher inflation on some of the dollar store merchandise will eventually add to Family Dollar's and other dollar stores' margins. (For related reading, see The Bottom Line On Margins.)

Family Dollar Stock
My sense is that the market has missed the call on Family Dollar's long-term prospects and the dollar store industry's future. This is because the ongoing demographic shift will be in Family Dollar's favor and the industry will retain many of its new customers. So, as the stocks are sold off and plunge, bargain hunters will know what to do. (Financial discipline is the key to successful growth in the retail industry. For further reading, see The 4 R's Of Investing In Retail.)

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